This report is designed to provide a basic understanding of auditor’s independence and responsibility to conduct audit in an effective manner. In this regard, practical examples of Clarke & Johnson and Mining Supplies Limited have been taken to explain the relevance of proper audit procedure in identifying business risks while carrying audit. The companies have the choice to audit certain assets for ensuring the reliability and compliance of their financial statements on the basis of Generally Accepted Accounting Principles. In the report, the theory has been linked with the auditing standards of Australia and auditors’ liabilities. Also, the various types of audit risks have been discussed.
Situation 1:
In the presented case, luxury Travel Holidays LTD (LTH), a travel company, was impressed with last year’s audit conducted by Clarke & Johnson (CJI), and reappointed it as its auditor for the upcoming audit of the 30 June 2015 financial report. However, the board of LTH would also want to invite Geoff, an audit partner to give a speech about LTH at the next travel agency seminar, to assist in promoting LTH’s business to attract more investors. This practice is against the ethical standards of Australian Audit as it lies beyond the ordinary audit practices or is non-audit service.
Situation 2:
In the presented case, Chris, the CEO of luxury Travel Holidays (LTH) is presenting a complimentary 14-day holiday package voucher for Geoff and his family to the Greek. This is because Chris wants to express his sincerity towards the audit firm CJ and Geoff, and to maintain the good relationship in anticipation of another smooth audit for 2015. This attitude of Chris can create the threat of self-interest and familiarity for Geoff and CJ. As a result, he may fail to provide true opinion on the financial statements of LTH.
Situation 3:
In the presented case, Michael, one of the team members of CJ auditing firm, believes that he may become the valuable asset to the client as his father is employed as financial controller in LTH. It indicates that Michael can face the threat of familiarity during the audit process and may not be able to give honest audit opinion about LTH’s financial position and related internal controls.
Situation4:
In the stated case, Annette was earlier appointed on the temporary assignment in LTH for assisting the client with its tax calculations and preparing accounting entries that will be reflected in the 30 June 2015 financial report. In this regard, Annette can face the threat of advocacy while doing LTH’s audit due to the pressure of the management.
Considering the high-status accounting scandals in the recent years, the integrity and independence of auditors have been doubted. They were suspected to have insufficient knowledge of the business risks and exposures of the company, which made them to neglect the effects of client’s aggressive accounting policies. In this view, International Standards of Auditing (ISA) requires auditors to gain a proper understanding of the client’s business and associated risks at audit planning stage only (Chevers et al., 2016).
In the presented case, Mining Supplies limited sells mining equipment and spare parts to mining companies across Australia. MSL has equipment purchase order contracts with a number of manufacturing suppliers based in Europe, Us and China. These manufactures build the specialised, made- to-order equipment and spare parts and ship them to MSL’s operational centres. In this case, the business risk may arise from a contracting customer base which increases the risk of material misstatement associated with the valuation of spare parts. While planning the audit for 2015, the auditor is responsible for recognizing the complexity of purchase value considerations related to equipments and spare parts purchased by MSL (Drew, and Dollery, 2015). Crampton and Hasaad are required to verify the fair market value of the equipments purchased. In order to apply professional judgement, both of them should clarify any disagreements with each other.
However, Crampton and Hasaad don’t have the duty to determine or evaluate all the business risks as all business risks do not lead to risk of material misstatement. In this regard, the auditors should emphasize on verifying transactions rather than examining account balances. Audit period transactions should also be given attention, which include additions, disposals, write-offs, and depreciation. The auditor should check whether the client has made appropriate arrangements for the obsolescence or impairment of equipments (Xu et al., 2013). Other factors that should be considered while planning audit are actual cost of the equipment purchased as a part of group purchase, and amortisation or depreciation which does not represent the economic use of the asset.
While determining the business risks, Crampton and Hasaad are required not only to verify the accuracy of the equipment and spare parts, but also to ask necessary questions with the management of MSL such as, what risks does this business face? Having recognized the risks confronted by the entity being audited? How is the entity managing or dealing with these risks? In order to verify the spare parts, Crampton and Hasaad will carry out substantive procedures and will examine the opening balance from previous year’s financial statements and audit working papers (Amir et al., 2014).
The term ‘audit risk’ refers to the risk that an auditor may not issue accurate and unbiased view of the client’s financial information due to non-detection of material misstatement during audit process. It is the duty of an auditor to identify and consider audit risk and materiality both in planning the audit and audit procedures. The auditor is also needed to assess if the client’s financial statements are presented in a fair way and in conformity with GAAPs (Contessotto, and Moroney, 2014). Considering audit risk and materiality help the auditor in getting sufficient evidences which are important to analyse the financial statements and related internal controls. It is a well-known fact that every audit work involves risk to some extent.
These risks are likely to arise mainly due to insufficient sample sizes taken by the auditor while examining the extent of risk, or improper use of auditing policies. To evaluate the level of risk associated with particular areas in the presented case, three elements are helpful, which are inherent risk, control risk, and detection risk (Stewart et al., 2015). The inherent risk refers to the environmental factors such as business background of MSL and audit reports of past audits.
In addition to this, Crampton and Hasaad should discuss about the possibility of material misstatement in MSL’s financial information because of fraud, and other internal as well as external factors (Hribar et al., 2014). These factors may pressurize the management and others to commit cheat. Also, the discussion should consider the risk of management overrule of controls. A proper planning should be conducted on how to respond effectively to the vulnerability of the MSL’s financial information due to fraud. Both the audit partners are required to emphasize the need to maintain a questioning mind and practice professional scepticism in collecting and analyzing evidences throughout the whole audit procedure.
Moreover, Crampton and Hasaad should consider any unusual or unexpected relationships, if found during analytical procedures in planning the audit. If more than one fraud risk factors are found, the investigation should be extended. Information from third parties such as client’ customers, bankers, and suppliers should also be gathered to discover the fraud. As per section 319, auditors should obtain better knowledge of all elements of internal controls implemented by the management of MSL. Thus will support them in determining various types of potential misstatements and consider factors which are important to influence the risk of potential mistreatment, develop the applicable tests of controls, and substantive procedures (Kerazan, 2017). The programs executed by the management should be evaluated to identify frauds placed at operations. These programs may include promoting atmosphere of integrity and ethical behaviours. The auditors should determine if such programs are able to eliminate the identified risks of major risks. It also helps in preventing and detecting fraud and errors on time.
Conclusion
On the basis of above discussions, it can be concluded that audit risk is a vital component of an audit process. The auditors are required to properly and completely understand the misstatements and their impact on clients’ financial statements. From the case of Mining Supply Limited, it can also be reflected that both audit risk and materiality influence the adoption of GAAPs, mainly the standards of field work and reporting in the audit details. Thus, these factors should be taken into account while determining the nature, timing, and degree of auditing procedures and in measuring the outcomes of those procedures.
References
Abbott, L.J., Daugherty, B., Parker, S. and Peters, G.F., (2016) ‘Internal audit quality and financial reporting quality: The joint importance of independence and competence’, Journal of Accounting Research, 54(1), pp.3-40.
Amir, E., Kallunki, J.P. and Nilsson, H., (2014) ‘The association between individual audit partners’ risk preferences and the composition of their client portfolios’, Review of Accounting Studies, 19(1), pp.103-133.
Carey, P.J., Monroe, G.S. and Shailer, G., (2014) ‘Review of post-CLERP 9 Australian auditor independence research’, Australian Accounting Review, 24(4), pp.370-80.
Chevers, D., Lawrence, D., Laidlaw, A. and Nicholson, D., (2016) ‘The effectiveness of internal audit in Jamaican commercial banks’, Journal of Accounting and Management Information Systems, 15(3), pp.522-541.
Contessotto, C. and Moroney, R., (2014) ‘The association between audit committee effectiveness and audit risk’, Accounting & Finance, 54(2), pp.393-418.
Crockett, M. and Ali, M.J., (2015) ‘Auditor independence and accounting conservatism: Evidence from Australia following the corporate law economic reform program’, International Journal of Accounting & Information Management, 23(1), pp.80-104.
Drew, J. and Dollery, B., (2015) ‘Inconsistent depreciation practice and public policymaking: Local government reform in New South Wales’, Australian Accounting Review, 25(1), pp.28-37.
Hribar, P., Kravet, T. and Wilson, R., (2014) ‘A new measure of accounting quality.’,Review of Accounting Studies, 19(1), pp.506-538.
Kerazan, F.H., (2017) ‘The Contribution of the Internal Audit Function in Risk Management’, Journal of Management Research, 8(3), pp.178-202.
Stewart, J., Kent, P. and Routledge, J., (2015) ‘The association between audit partner rotation and audit fees: Empirical evidence from the Australian market’, Auditing: A Journal of Practice & Theory, 35(1), pp.181-197.
Xu, Y., Carson, E., Fargher, N. and Jiang, L., (2013) ‘Responses by Australian auditors to the global financial crisis’, Accounting & Finance, 53(1), pp.301-338.
This report is designed to provide a basic understanding of auditor’s independence and responsibility to conduct audit in an effective manner. In this regard, practical examples of Clarke & Johnson and Mining Supplies Limited have been taken to explain the relevance of proper audit procedure in identifying business risks while carrying audit. The companies have the choice to audit certain assets for ensuring the reliability and compliance of their financial statements on the basis of Generally Accepted Accounting Principles. In the report, the theory has been linked with the auditing standards of Australia and auditors’ liabilities. Also, the various types of audit risks have been discussed.
Situation 1:
In the presented case, luxury Travel Holidays LTD (LTH), a travel company, was impressed with last year’s audit conducted by Clarke & Johnson (CJI), and reappointed it as its auditor for the upcoming audit of the 30 June 2015 financial report. However, the board of LTH would also want to invite Geoff, an audit partner to give a speech about LTH at the next travel agency seminar, to assist in promoting LTH’s business to attract more investors. This practice is against the ethical standards of Australian Audit as it lies beyond the ordinary audit practices or is non-audit service.
Situation 2:
In the presented case, Chris, the CEO of luxury Travel Holidays (LTH) is presenting a complimentary 14-day holiday package voucher for Geoff and his family to the Greek. This is because Chris wants to express his sincerity towards the audit firm CJ and Geoff, and to maintain the good relationship in anticipation of another smooth audit for 2015. This attitude of Chris can create the threat of self-interest and familiarity for Geoff and CJ. As a result, he may fail to provide true opinion on the financial statements of LTH.
Situation 3:
In the presented case, Michael, one of the team members of CJ auditing firm, believes that he may become the valuable asset to the client as his father is employed as financial controller in LTH. It indicates that Michael can face the threat of familiarity during the audit process and may not be able to give honest audit opinion about LTH’s financial position and related internal controls.
Situation4:
In the stated case, Annette was earlier appointed on the temporary assignment in LTH for assisting the client with its tax calculations and preparing accounting entries that will be reflected in the 30 June 2015 financial report. In this regard, Annette can face the threat of advocacy while doing LTH’s audit due to the pressure of the management.
Considering the high-status accounting scandals in the recent years, the integrity and independence of auditors have been doubted. They were suspected to have insufficient knowledge of the business risks and exposures of the company, which made them to neglect the effects of client’s aggressive accounting policies. In this view, International Standards of Auditing (ISA) requires auditors to gain a proper understanding of the client’s business and associated risks at audit planning stage only (Chevers et al., 2016).
In the presented case, Mining Supplies limited sells mining equipment and spare parts to mining companies across Australia. MSL has equipment purchase order contracts with a number of manufacturing suppliers based in Europe, Us and China. These manufactures build the specialised, made- to-order equipment and spare parts and ship them to MSL’s operational centres. In this case, the business risk may arise from a contracting customer base which increases the risk of material misstatement associated with the valuation of spare parts. While planning the audit for 2015, the auditor is responsible for recognizing the complexity of purchase value considerations related to equipments and spare parts purchased by MSL (Drew, and Dollery, 2015). Crampton and Hasaad are required to verify the fair market value of the equipments purchased. In order to apply professional judgement, both of them should clarify any disagreements with each other.
However, Crampton and Hasaad don’t have the duty to determine or evaluate all the business risks as all business risks do not lead to risk of material misstatement. In this regard, the auditors should emphasize on verifying transactions rather than examining account balances. Audit period transactions should also be given attention, which include additions, disposals, write-offs, and depreciation. The auditor should check whether the client has made appropriate arrangements for the obsolescence or impairment of equipments (Xu et al., 2013). Other factors that should be considered while planning audit are actual cost of the equipment purchased as a part of group purchase, and amortisation or depreciation which does not represent the economic use of the asset.
While determining the business risks, Crampton and Hasaad are required not only to verify the accuracy of the equipment and spare parts, but also to ask necessary questions with the management of MSL such as, what risks does this business face? Having recognized the risks confronted by the entity being audited? How is the entity managing or dealing with these risks? In order to verify the spare parts, Crampton and Hasaad will carry out substantive procedures and will examine the opening balance from previous year’s financial statements and audit working papers (Amir et al., 2014).
The term ‘audit risk’ refers to the risk that an auditor may not issue accurate and unbiased view of the client’s financial information due to non-detection of material misstatement during audit process. It is the duty of an auditor to identify and consider audit risk and materiality both in planning the audit and audit procedures. The auditor is also needed to assess if the client’s financial statements are presented in a fair way and in conformity with GAAPs (Contessotto, and Moroney, 2014). Considering audit risk and materiality help the auditor in getting sufficient evidences which are important to analyse the financial statements and related internal controls. It is a well-known fact that every audit work involves risk to some extent.
These risks are likely to arise mainly due to insufficient sample sizes taken by the auditor while examining the extent of risk, or improper use of auditing policies. To evaluate the level of risk associated with particular areas in the presented case, three elements are helpful, which are inherent risk, control risk, and detection risk (Stewart et al., 2015). The inherent risk refers to the environmental factors such as business background of MSL and audit reports of past audits.
In addition to this, Crampton and Hasaad should discuss about the possibility of material misstatement in MSL’s financial information because of fraud, and other internal as well as external factors (Hribar et al., 2014). These factors may pressurize the management and others to commit cheat. Also, the discussion should consider the risk of management overrule of controls. A proper planning should be conducted on how to respond effectively to the vulnerability of the MSL’s financial information due to fraud. Both the audit partners are required to emphasize the need to maintain a questioning mind and practice professional scepticism in collecting and analyzing evidences throughout the whole audit procedure.
Moreover, Crampton and Hasaad should consider any unusual or unexpected relationships, if found during analytical procedures in planning the audit. If more than one fraud risk factors are found, the investigation should be extended. Information from third parties such as client’ customers, bankers, and suppliers should also be gathered to discover the fraud. As per section 319, auditors should obtain better knowledge of all elements of internal controls implemented by the management of MSL. Thus will support them in determining various types of potential misstatements and consider factors which are important to influence the risk of potential mistreatment, develop the applicable tests of controls, and substantive procedures (Kerazan, 2017). The programs executed by the management should be evaluated to identify frauds placed at operations. These programs may include promoting atmosphere of integrity and ethical behaviours. The auditors should determine if such programs are able to eliminate the identified risks of major risks. It also helps in preventing and detecting fraud and errors on time.
Conclusion
On the basis of above discussions, it can be concluded that audit risk is a vital component of an audit process. The auditors are required to properly and completely understand the misstatements and their impact on clients’ financial statements. From the case of Mining Supply Limited, it can also be reflected that both audit risk and materiality influence the adoption of GAAPs, mainly the standards of field work and reporting in the audit details. Thus, these factors should be taken into account while determining the nature, timing, and degree of auditing procedures and in measuring the outcomes of those procedures.
References
Abbott, L.J., Daugherty, B., Parker, S. and Peters, G.F., (2016) ‘Internal audit quality and financial reporting quality: The joint importance of independence and competence’, Journal of Accounting Research, 54(1), pp.3-40.
Amir, E., Kallunki, J.P. and Nilsson, H., (2014) ‘The association between individual audit partners’ risk preferences and the composition of their client portfolios’, Review of Accounting Studies, 19(1), pp.103-133.
Carey, P.J., Monroe, G.S. and Shailer, G., (2014) ‘Review of post-CLERP 9 Australian auditor independence research’, Australian Accounting Review, 24(4), pp.370-80.
Chevers, D., Lawrence, D., Laidlaw, A. and Nicholson, D., (2016) ‘The effectiveness of internal audit in Jamaican commercial banks’, Journal of Accounting and Management Information Systems, 15(3), pp.522-541.
Contessotto, C. and Moroney, R., (2014) ‘The association between audit committee effectiveness and audit risk’, Accounting & Finance, 54(2), pp.393-418.
Crockett, M. and Ali, M.J., (2015) ‘Auditor independence and accounting conservatism: Evidence from Australia following the corporate law economic reform program’, International Journal of Accounting & Information Management, 23(1), pp.80-104.
Drew, J. and Dollery, B., (2015) ‘Inconsistent depreciation practice and public policymaking: Local government reform in New South Wales’, Australian Accounting Review, 25(1), pp.28-37.
Hribar, P., Kravet, T. and Wilson, R., (2014) ‘A new measure of accounting quality.’,Review of Accounting Studies, 19(1), pp.506-538.
Kerazan, F.H., (2017) ‘The Contribution of the Internal Audit Function in Risk Management’, Journal of Management Research, 8(3), pp.178-202.
Stewart, J., Kent, P. and Routledge, J., (2015) ‘The association between audit partner rotation and audit fees: Empirical evidence from the Australian market’, Auditing: A Journal of Practice & Theory, 35(1), pp.181-197.
Xu, Y., Carson, E., Fargher, N. and Jiang, L., (2013) ‘Responses by Australian auditors to the global financial crisis’, Accounting & Finance, 53(1), pp.301-338.
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